Multiple

What Is a Multiple?

A multiple measures some aspect of a company's financial well-being, determined by separating one metric by another metric. Metrics are quantitative tools that measure a company's performance. The metric in the numerator is typically larger than the one in the denominator. Investors use multiples to measure a company's growth, productivity, and efficiency. They use multiples to make comparisons among companies and track down the best investment opportunities.

For example, a multiple can be used to show how much investors will pay per dollar of earnings, as computed by the price-to-earnings (P/E) ratio. Assume you are breaking down a stock with $2 of earnings per share (EPS), which is trading at $20. This stock has a P/E of 10. This means investors will pay a multiple of 10 times the current EPS for the stock.

This is calculated as:

Understanding Multiples

In the world of stock valuation, investors and analysts generally rely on two major methods. One is based on cash flow, while the other is based on a multiple of some performance measure, like earnings or sales. Valuation based on cash flow (i.e., the discounted cash flow analysis) is considered to be an intrinsic valuation. Valuation based on a multiple is considered to be relative because the multiple is relative to some performance measure. The multiples approach to valuation is a theory based on the concept that comparable assets ought to sell at comparable costs.

Price-to-Earnings (P/E) Multiple

The most common multiple used in the valuation of stocks is the P/E multiple. It is used to compare a company's market value (price) with its earnings. A company with a price or market value that is high compared to its level of earnings has a high P/E multiple. A company with a low price compared to its level of earnings has a low P/E multiple.

A P/E of 5x means a company's stock is trading at a multiple of five times its earnings. A P/E of 10x means a company is trading at a multiple that is equal to 10 times earnings. A company with a high P/E is considered to be overvalued. Likewise, a company with a low P/E is considered to be undervalued.

EV/EBITDA Multiple

Enterprise value (EV) is a popular performance metric used to calculate different types of multiples. EV shows how much money would be needed to buy a specific company. The EV of a company is calculated by taking the company's market capitalization, adding total debt (counting long-term and short-term debt), and deducting all endlessly cash equivalents. Numerous investors see EV as a better performance metric than relying on market capitalization alone because it offers a more complete picture of a company's valuation.

A widely used multiple is the EV to earnings before interest, taxes, depreciation, and amortization (EBITDA) multiple, likewise referred to as EV/EBITDA. This multiple helps investors compare companies in the same industry or sector before pursuing an investment choice.

Numerous equity analysts consider EV/EBITDA to be a strong measure of cash flow available to a firm.

EV/EBIT Multiple

The EV to earnings before interest and taxes (EBIT) multiple, likewise referred to as EV/EBIT, is like the P/E multiple, yet is preferred by some analysts for its ability to give a more complete picture of a company's financial performance and genuine worth. The multiple is useful for pinpointing companies that may be undervalued or overvalued. It's best used for less capital-intensive companies, with fewer depreciation and amortization expenses.

EV/Sales Multiple

The EV to sales ratio, likewise referred to as EV/sales, compares the enterprise value of a company to its annual sales. The EV/sales multiple is considered an important valuation tool because it takes into account a company's equity and debt while providing investors with a quantifiable metric of how to value a company based on sales. It's likewise useful in evaluating companies with negative earnings. To be best, investors ought to compare the EV/sales multiple of the company they are dissecting to that of other companies in the same industry.

Highlights

• The most common multiple used in the valuation of stocks is the price-to-earnings (P/E) multiple.
• Enterprise value (EV) is a popular performance metric used to calculate different types of multiples, like the EV to earnings before interest and taxes (EBIT) multiple and the EV to sales multiple.
• A multiple measures the well-being of a company by comparing two metrics, as a rule by separating one by the other.
• Investors generally rely on two stock valuation methods: one based on cash flow and the other based on a multiple of a performance measure.